The E-Cigarette Industry in China

1. The E-Cigarette Industry in China By Roger Luo Operation Director of CECMOL

2. Introduction of CECMOL Purpose: To promote tobacco harm reduction, improve people’s life quality, and build a smoke-free society. 1. E-cigarette Industry Association 2. Held the first and biggest E-cigarette Forum in China. 3. Organized the first Vapor Expo in China 4. World No-smoking Day: Press Conference 5. Our next Vapor Expo: October 20-23 2015, Shenzhen

3. The 2rd CECMOL China International Vapor ExpoOctober 20-23 2015 The 3rd CECMOL China E-cig Summit ForumApril 10-11, 2016Shenzhen Convention and Exhibition Center

5. Contents Market Environment of E-cigarette in China Market Capacity of E-cigarette in China Consumer Behavior of E-cigarette Market in China Consumer Preference of E-cigarette in China Historical Sales Data of E-cigarette in China Suggestions on Future Development of E-cigarette Industry

6. In 2003, E-cigarette was invented;in 2004, patent was filed. In 2005, E-cigarette was introduced to Europe by the British. In 2007, E-cigarette entered the US market. With the reputation of “tobacco alternative” and “smoking cessation product”, E-cigarette attracts the attention of global smokers.Statistics show that in 2011 in Japan and the USA the tobacco sales dropped by 10.8% and 2.8% respectively, while E-cigarette sales had significant increase. Therefore, when E-cigarette is noticed by tobacco consumers, the market starts transforming and developing.

7. Mr. Ling, the leader ofChina Tobacco, has attached importance to domestic market of E-cigarette in China. On the National Tobacco Industry Conference this year, Mr. Ling pointed out that “We should grasp the international tobacco market trends, attach great importance to the research and development of new tobacco products, such as heat-not-burn cigarette, E-cigarette, Snus etc, and take it as the major project for the sustainable development of the industry. The China Tobacco has set up a leading team to work on the planning, designing and major projects of new tobacco products.”

8. With such development trend, what’s the policy environment?

9. World Health Organization strengthens supervision Since 2008, WHO Framework Convention on Tobacco Control (FCTC) has gradually brought E-cigarette and other tobacco alternatives into supervision. In 2010, according to the 4th session of the Conference of the Parties to the WHO FCTC, WHO published a report: Control and Prevention of Smokeless Tobacco Products and Electronic Cigarette. On the 5th session of the Conference of the Parties to the WHO FCTC, WHO confirmed regulations on prevention and control of smokeless tobacco products, electronic cigarettes and nicotine alternatives; had health hazard tests on new nicotine alternatives and submitted the results to the 6th session in 2014 for further discussion.

10. Regulations in China China Tobacco regards the contents of E-cigarette as high purity nicotine extracted from tobacco, so it suggests State Administration of Work Safety be responsible for the regulations, according to Hazardous Chemicals Control Ordinance. State Administration of Work Safety thinks that it’s only responsible for the safety of production and transportation of hazardous chemicals, but it’s other regulator’s responsibility for the possible hazard from consuming hazardous chemicals. However, there’s no legal restrictions on consuming nicotine at present in China.

11. How to analyze the policies?

12. Legislation Comes First Tobacco Monopoly Law came into effect in 1991. It’s amended in 2009, but it’s not binding for E-cigarettes. There should be at least 5 conditions for legislation: WHO must confirm whether the smoking conditions of traditional cigarette apply to E-cigarette; WHO must confirm whether E-cigarette is harmful to human health; Some countries have legislations on E-cigarette, which can be used as reference in China; According to the feedback from domestic market, E-cigarette is growing continuously and exponentially in China. Some e-cigarette brands have been involved in the competition of global tobacco market.

13. The Twelfth Five-year Plan of Tobacco In the 12th Five-year Plan (2011-2015) made by China Tobacco, the core strategic target is “upper level of tobacco”, and there’s no planning or goal about E-cigarette, which is one of the reasons why it’s not regulated at present. After the change in leadership of China Tobacco in 2014, the new Leader Mr. Ling’s comments means strategic planning for E-cigarette. However, at the end of the 12th Five-year plan, there’s little possibility of setting clear regulations for E-cigarette. Thus in the near future there will still be lack of regulations.

14. The 13th Five-year Plan will come to a conclusion (2016-2020) Two hot phrases before the 13th Five-year Plan: New Normal: the new normal of the market segment of traditional cigarette, and the new normal of technological innovation. Three Major Issues: a. How to gain bonus from reforming? To adhere to the monopoly system of tobacco. b. How to reach the potential of development? To focus on the new development of global market. c. What is our goal? To aim at reaching global prominence and catching up with the Top 3 multinational brands.

15. When will E-cigarette be regulated in China? Analysts conservatively estimate that in 2 years (2017) the policy will be gradually clear; at the end of the 13th Five-year Plan, there will be clear regulations.

16. Contents Market Environment of E-cigarette in China Market Capacity of E-cigarette in China Consumer Behavior of E-cigarette Market in China Consumer Preference of E-cigarette in China Historical Sales Data of E-cigarette in China Suggestions on Future Development of E-cigarette Industry

17. The E-cigarette Consumption Rate in major cities of China According to the statistics of the 5 major cities, the E-cigarette consumption rate is 3.4%, among which the rate in Beijing is the highest, followed by Shanghai and Guangzhou; the rate in Xi’an is close to average, while Harbin’s rate is only 1.7%, much lower than average. The percentage of E-cig consumption in the past half a year(N=2038) Source: CATI

18. E-commerce (online)Sales • Taobao.com: 1575online stores. A level stores: 59; B level: 565;C level: 683. • Tmall.com: 71 online stores. Mostly are flagship stores and self-owned domestic brands; seldom international brands. • Main stores: top-ranked stores are from Tmall.com, mainly are self-owned brands made in China. • Search engine index: the site search index is increasing, and in July 2014the average number of people who search is 43,000; the industry search index vs. product index of all sites is 1:0.8. The market capacity is huge and the competition is small, indicating a good trend.

19. Estimation on E-cigarette Market Capacity Formula: Market Capacity=population * percentage of ppl aging 15 - 64* usage rate * percentage of E-cigarette usage* E-cigarette average usage each year • ①This is the first field research on E-cigarette in China, so there’re no other case study data about E-cigarette usage for reference. • ②This CATI research is based on 500 samples of each city; since the E-cigarette usage rate is low, so that in the sample database the number of people using E-cigarette in each city is too low, plus in the database the frequency of using E-cigarette by consumers is too scattered, so it can’t be regarded as effective reference. • ③According to the data of consumer questionnaire collected by an entrusting party, the frequency of using E-cigarette by consumers is: 21.5% consume 1 piece or above per day on average, 13% consume 4 to 6 pieces (include refills) per week, 10% consume 2-3 pieces (include refills) per week, 10.4% consume 1 piece (include refills ) per week, 22.6% consume 2 to 3 pieces (include refills) per month, 10.7% consume 1 piece (include refills) per month, 5.25% consume 1 piece (include refills) every 2 months, 6.7% consume less than 1 piece every 2 month on average. Based on this frequency, it’s estimated that the average usage is 118 to 789 pieces (include refills) per person per year; since the data of Beijing, Xi’an and Shanghai are not ideal, it’s conservatively estimated as 118 pieces of E-cigarette usage per person per year in those 3 cities. • ④This research is based on a small scale of consumer questionnaires, so the estimated average annual use of E-cigarette usage is only for reference.

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21. Contents Market Environment of E-cigarette in China Market Capacity of E-cigarette in China Consumer Behavior of E-cigarette Market in China Consumer Preference of E-cigarette in China Historical Sales Data of E-cigarette in China Suggestions on Future Development of E-cigarette Industry

22. The Characteristics of domestic E-cigarette consumers The average age of E-cigarette consumers is 33.5years old, and there are mainly 2 kinds: 1. Moderate to heavy smokers (daily smoking is over 15 pieces of cigarettes), trying to quit smoking gradually; 2. Young light smokers(daily smoking is less than 8 pieces),regarding E-cigarettes as fashion and fun. College degree or above accounts for 53.6%, overall education is above average;income peaks at 2 levels, one is for low income groups whose annual family income is 10,000 to 50,000RMB, and the other is relatively high income groups whose annual family income is 100,000 to 200,000RMB, among which those with annual family income over 100,000RMB account for 33.9%。 Occupation Source: CATI Education Annual Family Income (10,000) Annual Individual Income (10,000)

23. The Reason Why People Use E-cigarette Reasons for using E-cigarette • Compared with traditional cigarette, E-cigarette’s unique feature is the biggest attraction for consumers; it’s healthier, less harmful, brings consumers certain satisfaction, which has a great appeal to them. • E-cigarette is a symbol of identity. It indicates good taste, high-level and individuation, which is another feature to attract consumers. • E-cigarette products’ diversity is realized by a few people gradually. • Others’ recommendation is another driving force for consumers to use E-cigarettes.

24. Price Material Domestic/ Imported Brand Technology Appearance Flavor Division Criteria Division Criteria for E-cigarette by Domestic Consumers Division criteria include price, domestic/imported, product, packaging, brand, material etc, but for most consumers, price is an important criterion, as well as the popularity and quality of the brand.At present most consumers are emotional for dividing E-cigarettes. • The most intuitivecriterion • Imported is high level • Domestic is mid-low level • Refill is good • Disposable is not good • Better flavor, higher level • Woodiness is better; • On the market there’re more disposable & EGO Good brand is good-looking, with better techniques, safe to use. Battery, atomizer, nozzle, packaging • In the interviews most consumers divide e-cigarettes on a superficiallevel, they have much blindness on dividing E-cigarettes: • Price is the most intuitive criterion for consumers; • Imported E-cigarette is better than domestic ones. • Other consumers have good knowledge of E-cigarette products, and they are more rational when dividing E-cigarettes.

25. Contents Market Environment of E-cigarette in China Market Capacity of E-cigarette in China Consumer Behavior of E-cigarette Market in China Consumer Preference of E-cigarette in China Historical Sales Data of E-cigarette in China Suggestions on Future Development of E-cigarette Industry

26. Features of good E-cigarettes – different levels Consumers divide E-cigarettes from brand, packaging, technique, flavor etc, but different levels of consumers have different division criteria: High-end consumers are rational, instead of caring about the appearance, they evaluate E-cigarette from its techniques, such as the model, exquisiteness, fashionable taste, volume of cloud or sealability etc. Although such consumers haven’t made clear requirements for brands, their demand for high quality products indicates that for high-end consumers, good E-cigarettes need to be of high quality and created by really good brands. Mid-end consumers care more about brand and packaging, believing that good E-cigarettes should be famous, upscaleand with exquisite packaging. Ordinary consumers care more about the product itself instead of the brand; they focus on the flavor and sense of satisfactio, and they have direct & clear requirements about packaging. Low to High • Flavor • More direct need for ordinary consumers • Technology • Criterion of high-end consumers Middle to High • Requirement of mid-end consumers • Packaging • Necessary & basic criterion for mid-end consumers • Brand (famous, upscale)

27. Features of good E-cigarettes • Specifically,we define good E-cigarettes from the flavor, model, packaging and techniques. Here are the features of good E-cigarettes considered by consumers: • Flavor：pure natural flavor of tobacco, original flavor; mellow and soft, a sense of satisfaction. Change to other flavors once in a while. • Techniques • Appearance • Feel great in the hand; • Taste great, easy to smoke; • Good sealability, no e-liquid leak. • Portable, fashionable, simple; • Upscale, has a deep culture & connotation; • Received recognition from most mid-high end consumers (such as pipe model) Brand • External Packing • Single Packing • Upscale, presents nobility; • Color not too bright, better be calm & decent; • Has it’s own feature, great visual effect to be easily remembered; • Material: most consumers recommendwood box or similar as iPhone packing. • For refillable E-cigarettes, single packing has great sales potential; • For disposable E-cigarettes, most consumers regard a pack of 5pcs as the best. But refillable E-cigarettes are more popular among consumers.

28. Consumer Preference on Flavor Flavor Preference - Overall Specifically, consumers prefer E-cigarette with original flavor, especially in Shenzhen and Beijing, followed by Harbin, Guangzhou and Xi’an; Consumers in Shanghai have great interest in new flavors, such as fruit, wood, cocoa etc. In terms of age, young consumers aging from 18 to 35 prefer other flavors, and easier to accept mixed or additive flavors. Flavor Preference - City Flavor Preference - Age Source: Consumer Questionnaire

29. Consumer Preference on Appearance From the appearance, consumers prefer portable and pipe model, between disposable and personalized ones. For pipe model, consumers preference in Shanghaiaccounts for 73.8%which is high, followed by Beijing. In terms of age, young consumers prefer portable E-cigarettes, while elder ones prefer pipe model.It can be seen that young consumers pursue the fashion, while elder ones prefer the cultural charm. Appearance Preference - Overall Appearance Preference - City Appearance Preference - Age Source: Consumer Questionnaire

30. Consumers hope we will have publicity or promotion about E-cigarettes as currently there’s none. In terms of the category of E-cigarette, it should be based on promoting a healthy and relaxing lifestyle, combined with E-cigarette branding; meanwhile, run promotions like terminal display. However, different consumers prefer different promotions: High-end consumers dislike discounts; they believe we should focus on brand culture for promotions, such as tasting, introducing E-cigarette experts, or providing brands in high-end places etc; Mid-end consumers prefer promotions that promote them more about E-cigarette products & flavors, cultivating them for a better taste, such as giving away E-cigarette professional appliances etc; Ordinary consumers are more pragmatic, preferring promotions like giving away gifts etc. 四、宣传与推广偏好 • Mid-high End Consumers • Ordinary Consumers Cultural Promotion Not mentioned Promote the taste & brand culture of E-cigarette Brand Publicity Advertisements, bars/clubs, websites (brand awareness; benefits of using E-cig: healthy, flavors) Fashion magazines, introduce E-cig experts, provide E-cig in high-end places or hotels. (Brand stories, lifestyle, usage) Distribution Channel • Websites, supermarkets, tobacco specialty shops, cigarette and wine shop High-end hotels, office buildings, clubs, coffee shops Style: low key, decent Terminal Display Great quantity & variety • Introduce the lifestyle, brand history and usage of • E-cigarettes. Ways of Promotion • No discounts • Free tasting • Give away disposables • Promotional benefits

31. Contents Market Environment of E-cigarette in China Market Capacity of E-cigarette in China Consumer Behavior of E-cigarette Market in China Consumer Preference of E-cigarette in China Historical Sales Data of E-cigarette in China Suggestions on Future Development of E-cigarette Industry

32. Analysis on Domestic Market Total Turnover of the Top 10 Brands on Taobao.com in 2012 to 2014 Source: database of Taobao.com Unit: CNY

33. In 2014, the E-cigarette market in China was growing dramatically, the market sales soared 263% year on year compared with 2013, and the number of consumers rose by 259% year on year. On one hand, consumers’ awareness of health increased; on the other hand, the products spread faster. In 2014, the total sales of Top 10 brands on Taobao.com reached 140 million yuan. The growth rate of 2015 is the same as that of 2014, which is estimated to exceed 400 million yuan on Taobao.com 。 Analysis on Domestic Market

34. E-cigarette Industry in China Top 10 Brands of Smoking Cessation Products in 2012

35. E-cigarette Industry in China Top 10 Brands of Smoking Cessation Products in 2013

36. E-cigarette Industry in China Top 10 Brands of Smoking Cessation Products in 2013

37. Analysis on E-cigarette Industry at Tmall.com Percentage of Top 10 Brands on Tmall.com in 2013

38. Analysis on E-cigarette Industry at Tmall.com Percentage of Top 10 Brands on Tmall.com in 2013

39. Contents Market Environment of E-cigarette in China Market Capacity of E-cigarette in China Consumer Behavior of E-cigarette Market in China Consumer Preference of E-cigarette in China Historical Sales Data of E-cigarette in China Suggestions on Future Development of E-cigarette Industry

40. As long as your product is good enough, people will choose it. The product is the basis for development of the industry, and continuous innovation is necessary for leading the industry and products to maturity. We should seek for combination point between the traditional tobacco products and electronic heat-not-burn cigarettes, or develop the similar flavors of traditional tobacco products for E-cigarettes. The flavor, sense of smoking and satisfaction of traditional cigarettes and individual needs will be the basis for the innovation of E-cigarette products.

41. Channel and convenience are the emphasis of marketing • According to the sales data of E-cigarette distribution channels, the traditional stores sales account for about 56%, while the sales of tobacco shops and online stores are only 20%. With the development of modern information technology, especially e-commerce, there’s wider space for the key enterprises launching marketing campaigns, building modern marketing network, and reducing marketing costs. Since 2012, Lorillard Tobacco Company has placed E-cigarette ads starred by famous actors on the US TV shows which have good results. The brand operation of E-cigarette not only requires increasing efforts on position design and tonal development, but also innovations on advertising screen, advertising channels, advertising language, sales methods, O2O (online and offline interaction), and crossover marketing etc.

42. Promotion and Communication Brand is the basic point Compared with traditional tobacco products, the prices of E-cigarettes are generally higher, ranging from tens of RMB to a few thousand RMB, sold as ordinary products or gifts. Most consumers are high-end, whose habits are developed for years and difficult to change. Instead of trying to change their habits, we can cater to them so that the consumers will enjoy the pleasure of tobacco alternatives and healthy vaping, while they are aware of the harm of smoking but not able to quit it. Thus they don’t have to change the habits or suffer from smoking cessation, but meanwhile their demands can be satisfied.

43. Focus on the domestic market Look to the international market In any emerging market, the freedom of development and competition is the greatest. We should grasp the opportunity to do everything possible to build our brands, grow them rapidly, form the scale, and seize the benefits! Within the limited time and space, we should have clear goals of developing brands, build sales network of brands, attract consumer groups for the brands, and create brand value and reputation! Strengthen the brand against any future risk of new policies and regulations. Focus on the domestic market to build the brand, and look to the international market for export!

44. The 2rd CECMOL China International Vapor ExpoOctober 20-23 2015 The 3rd CECMOL China E-cig Summit ForumApril 10-11, 2016Shenzhen Convention and Exhibition Center

46. Thank you!